Using Family Partnerships and LLCs to Protect Assets

The limited partnership was designed by law as a form of business organization that could be used by a group of owners and investors to undertake a commercial project or financial venture. But its structure can also be employed to facilitate estate planning and asset protection. For instance, the Family Limited Partnership (or FLP) is simply a regular limited partnership, organized under state law, in which the partners happen to be a closely-related group. In a typical FLP one or both parents are the general partners, and contribute all or most of the FLP's working capital and property, while the children fill the roles of limited partners. FLP's are generally best suited for estates consisting largely of real estate or family businesses. They're also often used for more liquid assets such as stocks and bonds, but not for professional firms or practices. This is because the use of money or other capital resources must be a major income-producing component of the family enterprise – as opposed to, for example, a medical practice, where personal services generate the bulk of the business's income.

Despite the personal liability of the general partner for partnership debts, the FLP provides reasonably good asset protection from future claims that arise outside of the partnership, such as an auto accident unrelated to business. For example, if a parent's investment property is placed in an FLP, they will then own only a partnership interest – not the actual property contributed. Therefore, by law, even if a creditor successfully sues the parent, the creditor would ordinarily be entitled only to a charging order, which is the right to the partner's future payments from the partnership (if the partnership decides to make any future payments). The creditor typically won't have the right to vote to liquidate the partnership or take a portion of the actual partnership property. That legal principle is the basis of the FLP's role in asset protection.

Another major advantage of the FLP is the way in which it facilitates transferring family wealth to the next generation. As an example, a family estate might consist of several rental properties and financial accounts. If all of the assets are put into the FLP, it becomes easier to give a son or daughter a certain number of limited partnership units rather than a portion of each asset. The value of these units for gift tax purposes can also be less than that of the underlying partnership assets, resulting in tax savings.

The limited partnership has been used for a number of years as a means of holding and distributing family wealth. The personal liability of the general partner, however, is a weakness in the limited partnership's asset protection structure. When this is a concern and no family member feels comfortable in taking on the role of the general partner, a limited liability company (LLC) can serve in that capacity. As general partner, the LLC itself would still have full liability for obligations of the limited partnership, but liability would stop there; no LLC owner would incur any personal liability.

LLC laws were designed to offer the best features of both partnerships and corporations. The LLC allows 'pass-through' taxation (as in a partnership) so that only the owners – not the business itself – pay tax. However, liability of the owners for the debts of the business is limited (like a corporation) to whatever stake that the individual owner has invested. In many states, the creditor-protection characteristics of an LLC are virtually the same as those of an FLP (assuming the FLP has a corporation or LLC as general partner). For this reason, the 'family' LLC plays an important role in many sophisticated asset protection plans, especially those involving ongoing family businesses. In estate planning, the main appeal of the family LLC – like the FLP – is in the facilitation of convenient, annual gift giving. In some circumstances, it also allows family wealth to be transferred from parents to children in a tax-efficient manner.

The family LLC can function in much the same way as the FLP in terms of both asset protection and estate planning. Their operation and benefits are best illustrated through the use of the example FLP below:

Let's say that two parents who own a sizeable estate of several million dollars want to protect their property from future legal claims and eventually transfer it to their children. Saving estate and gift tax is, of course, important; but even more so, they don't want to give up the control that they believe is inevitably lost by making substantial lifetime gifts. Under the advice of their attorney they create an FLP and place their property such as stock in the family company and real estate into it. One hundred limited partnership units, each representing a one percent ownership interest, are issued. The parents assume two ownership and management roles. As general partners (or through a LLC general partner that they've established), the parents take two units; they hold the remaining ninety-eight units in their other capacity as limited partners. Thus, they fully control the partnership business and property in their role as general partners, and they also own one hundred percent of the partnership.

Using this arrangement the parents' assets are legally protected to a large degree. Typical state limited partnership laws limit the liability of the limited partners for claims against the partnership itself. The general partner is personally liable, but if they use an LLC as the general partner, the parents themselves have no personal liability. If any claims arise (against either the parents or children) from outside the FLP, a creditor – after winning a judgment – would probably only be awarded a charging order by the court. Unfortunately, this would provide the creditor no control over the FLP or the assets that it owns. A charging order will generally only entitle the creditor to any distributions that the general partner decides the FLP should make to the limited partners. Such a prospect typically makes settling out of court a more agreeable option for most creditors.

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